Decision May Prolong Dearth of Bankruptcy Cases in New York

After many years of slow or no work, American corporate bankruptcy lawyers are again seeing signs of life in their corner of the world. But it still depends who you ask.

In particular, many local bankruptcy courts, and the court in Delaware, are benefiting from the growing number of Chapter 11 cases that are being filed by oil, coal and other energy companies. In New York, not so much.

The reasons are many. The United States Bankruptcy Court in the Southern District of New York has had a fairly significant turnover in the judges, while the composition in Delaware has been comparatively stable. Perhaps more important, many of the small- and midcap oil and gas companies that have been filing are incorporated in Delaware, but they have no connection with New York, making the Delaware venue much easier to justify.

Could this provide an opening for New York to finally get some of this new wave of cases?

Maybe, but it seems unlikely that this issue will have a great effect on where cases are filed.

Instead, I suspect that the easiest solution to this issue for most lawyers will be simply to raise their rates. The problem is simple: In a normal attorney-client engagement, only the client can object to the lawyer’s fees. In a bankruptcy case, anyone who is a party to the case can object.

This means that some fee objections will be part of litigation strategies, intended to impose costs on opposing counsel and influence their decisions in the case. Both debtor’s counsel and committee counsel potentially face such an attack.

To guard against this risk, lawyers wanted to include a provision in their retention agreements that would have given bankruptcy judges the ability to award fees in such situations, when the judges felt it was warranted. The United States Trustee, which acts as watchdog for professional fees in Chapter 11 cases, argued that the Supreme Court’s opinion in the Baker Botts case, which was not directly on this point, precluded such contracts. The Delaware courts agreed.

The fundamental question is whether winning this battle was actually in the best interest of the United States Trustee. Lawyers can be expected to seek a return in a bankruptcy case that is at least comparable to what they would get outside of bankruptcy. Outside of bankruptcy, they do not face the risk of uncompensated time spent defending their own fee application from a disgruntled third party.

So lawyers will raise their rates to account for this. Some will say that it is improper to change special “bankruptcy only” rates. Indeed, yet nothing stops a firm from raising its rates across the board, and then providing a discount to most clients, other than those involved in bankruptcy cases, of course.

So the United States Trustee has won the battle, but the result may be that professional fees become even less transparent than they were before. It is not clear that helps the United States Trustee fulfill its mission in the long run.

Stephen J. Lubben holds the Harvey Washington Wiley Chair in corporate governance and business ethics at Seton Hall Law School and is an expert on bankruptcy.